KISMAYU, Somalia Al Qaeda-linked militants, drug smugglers and shadowy criminal networks stand in the way of the Somali federal government's hopes of hiring a foreign firm to manage the lucrative but run-down southern port of Kismayu.

One of only three deep-water ports in Somalia, Kismayu's proximity to northern Kenya and Ethiopia has for decades made it integral to a thriving business smuggling arms, sugar and increasingly narcotics across porous east African borders.

Foreign powers trying to curb militant Islam in Somalia fret about the money-spinning charcoal trade that remains a big earner for the Islamist group al Shabaab. The U.N. Security Council has banned charcoal exports but the trade continues unabated in areas where the government holds little influence.

Rehabilitating the port is not only essential for generating new state revenues and creating jobs for former Islamist fighters, it is also vital to cutting off a steady flow of cash to al Shabaab, which showcased its threat to regional stability with September's bloody attack on a Nairobi mall.

"People have been making huge amounts of money from the ports and there are huge entrenched interests," said one Western diplomat. "If it could be run by a clean private sector provider, you would see a big increase in revenues."

Since the onset of the civil war in 1991, rival warlords and clan militias in need of cash to prop up their fiefdoms have often waged war for the right to collect taxes and control the flow of weapons through Somalia's Indian Ocean ports.

The man now running the city and its fertile hinterlands is a former Islamist warlord Ahmed Madobe.

"The president wants zero tolerance of corruption, he wants better management (but) capacity is very limited," Abdirahman Omar Osman, spokesman for the Somali presidency, told Reuters. "Therefore foreign companies who can help us get better in terms of efficiency and fighting corruption are wanted."

Improving Somalia's ports is crucial to rebuilding the country and denying Islamist militants a launchpad for strikes across the region. But any firm running Kismayu port will face powerful forces with an interest in keeping it dysfunctional.

While the gun-toting young men roaming Kismayu's port suggest little has changed in the past two decades, a thaw in relations between the central government and local administration heralds a rare opportunity for change.

"Life in Kismayu is getting better," said Faisal Abdiaziz, a 20-year-old laborer, who had also worked at the port when the Islamists were in charge. "My salary is now $300 and during al Shabaab it was $150," he said next to a crumbling warehouse.

SUGAR, DRUGS AND GUNS

To the annoyance of Western powers, al Shabaab continues profiting from Kismayu even after Kenyan troops fighting under an African Union peacekeeping banner and Madobe's own militia routed the militants from the port.

U.N. investigators monitoring the Somalia sanctions regime, said in July about 1 million sacks of charcoal worth $15 million to 16 million were exported every month from Kismayu alone in the months after Kenya and Madobe's Ras Kamboni militia won control of the city in September 2012.

Pointing to the business interests around the port, the investigators said Kenyan troops, Ras Kamboni and al Shabaab split the charcoal profits from Kismayu port with each other despite being at war. All three deny doing so.

A second diplomat working closely with regional intelligence said there was firm evidence that huge quantities of charcoal continue to be exported despite pressure on Kenya and Madobe. "Nothing has changed," said the diplomat.

A third diplomat added: "The Kenyan military officials will be key to any kind of improvements to the port."

Intelligence sources say the contraband route from Kismayu to the northern Kenyan town of Garissa has three layers, comprising sugar and electronics, hard drugs from Afghanistan and Pakistan region, as well as explosives and weapons.

A former Kenyan military officer with detailed knowledge of the smuggling routes said Kenya had since 2011 intensified checks on vehicles crossing the border due to worries about explosives destined for al Shabaab members inside Kenya.

But he said the crackdown has only had partial success: "The volume has reduced but the business is still going on."

Western security experts say the port has become a key entry point into east Africa for Afghan narcotics.

"It's not a port, it's a clearing house for drugs going into Kenya," said one Western security adviser.

Abdiqani Jama, a senior adviser to Madobe, said Dubai's DP World, the world's third largest port operator, and six other firms had shown interest in the port, including from China, Turkey, Kenya, South Africa and the United States.

No-one from DP World was immediately available for comment.

Jama said about $250 million dollars will be needed to rehabilitate the port, which is deeper than the port in the capital, Mogadishu.

"As part of this deal, we will give them 25 to 50 years (concession)," Jama told Reuters in Kismayu's windswept harbor.

RUSTING ORDNANCE, TURQUOISE WATERS

Whoever takes on the port faces a huge task. The first job will be to remove two sunken Somali warships which are laden with rusting ordnance beneath the harbor's turquoise waters.

The port will also have to be dredged for the first time in many years to allow large ships to dock. New warehouses are needed to replace the ruined ones dotted around the harbor.

"This port has been neglected," said Abdulahi Hadun, who took over as port manager when al Shabaab was chased out. "It has been used almost 50 years with no additional investment."

A Turkish company in October won a 20-year concession to run Mogadishu port, the federal government's biggest single revenue earner. Officials say a deal struck in August between the government and Madobe could pave the way for a similar arrangement in Kismayu.

But first the central government and regions need to agree on how to share port revenues. That will test Mogadishu's ties with Madobe in a country where conflict has largely been driven by competition for resources and clan loyalties.

Under the agreement, Madobe was due to hand over running of the port to the central government after 6 months but this has been delayed until an accord on revenues is achieved.

Presidential spokesman Osman said whoever takes over the running Somali ports will have to be acceptable to all sides.

"Revenue generated from the port will be spent in the regions so that they don't feel that Mogadishu is coming and taking away the resources," Osman said.

Stacks of cement, paint and other building materials lining the harbor point to a construction boom in Kismayu, where freshly painted murals advertise newly-opened tea shops and restaurants along the city's sandy streets.

Even though two of the four berths are blocked by the sunken warships and debris, the port employs over 3,000 people, mostly part time manual laborers, Hadun said. It is also the biggest revenue earner for the local administration.

"For us, two things are important: stability and job creation so people don't go back to al Shabaab," said Jama.

Pointing to several dozen manual laborers who were once al Shabaab fighters, mostly teens sporting threadbare soccer shirts, he added: "If you don't offer an alternative life from al Shabaab, they will then go back to their previous life."

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